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zh<>John Taylor On Why "Gridlock" Will Lead To A Slowing US Economy, A Drop In Equities And Commodities, And A Spike In The Dollar

Submitted by Tyler Durden on 01/06/2011 05:53 -0500

* Belgium
* Italy
* Japan
* National Health Service
* Obama Administration
* Recession



Gridlock or Trench Warfare?
January 6, 2011
By John R. Taylor, Jr.
Chief Investment Officer, FX Concepts

It seems almost impossible to compose a rational outlook for the world markets in this New Year without analyzing the political situation in Washington, but so many others seem to have sidestepped this elephant – appropriately the symbol of the Republican Party – that is taking up so much of the room. That’s a big mistake, as we believe that both the growth rate of the US economy and the course of global equity prices and other risk assets are hugely dependent upon the course of US politics in the next few months. The general nonchalance regarding Washington’s knotty political situation seems to derive from the historical fact that things tend to go rather well when the power in Washington is so diffuse that no one party has the power to move things in any direction at all. With gridlock, there will be no change, no new policies or programs that will upset the operation of the country, the real world, so we worker-bees can just ignore those news-hounds down there and keep the economy running. Gridlock has also been very helpful elsewhere, keeping many countries operating successfully over the years. Some examples that pop quickly to mind include Belgium – which hardly ever has a government at all – Italy – where the administrators are the only ones at work – and Japan – much like the Italians, but the politicians are probably less important and the administrators more competent. Unfortunately, caretaker governments and gridlock are far more successful when general economic conditions are good; when things turn nasty and decisions are needed, avoiding them or being so sclerotic that making them is impossible can be a very bad idea. We disagree with those who think that gridlock will be a good thing. From our point of view, even if the economy does chug along at 4%, gridlock is very dangerous.


For the next two years, trench warfare could be more likely than gridlock. I wish that we were like the British and could have another election quickly – like a few months from now, after we see how these guys work together – to roll the dice again. Back in 1950, when Labour was just barely holding on to power in London with a majority of five and decisions were difficult to make, they were gone by 1951, and the country went Conservative and off on a new tack. I choose that point in time to broadly compare the changes made by the Attlee Labour government, elected in 1945, with those of Obama. The Labour social and economic changes verged on the revolutionary, including the establishment of the National Health Service. Although the Obama administration’s health care overhaul was minor compared to Attlee’s universal creation, the American reaction appears to be more negative than the British one. The Labour expansion of government also dwarfed that under Obama, and despite much posturing, the Conservatives left most of the Labour directives alone. The 112th Congress just began today, but House Republicans have already laid out plans that are aimed at rolling back or not funding as many of the Obama programs as they can. As the Democrats control the Senate and the President has the veto as well, the programs are likely to survive the House challenges. However, these divisive tactics assure that pleasantries will be hard to come by in the Congress during the next year. Even the Fed looks like it will be dragged into this mud. If some decisions are necessary – the financial crises in state and municipal financing comes to mind – who is going to make the compromises to get the job done? God help the US if it goes into a recession and some real economic decisions, benefiting the workers or supplying capital or spending money, need to be made. It will be almost impossible to get a decision. Trench warfare is what we see and a deep recession is what we fear. Even growth below 2.5% would be very problematic and a big disappointment for the markets. Although we see equities down significantly, the dollar should rally and commodities decline as the US economy slows.